Author: Iralma Pozo, CPA
As a freelancer or independent contractor, a traditional retirement plan may not be an option for you. So, what should you do in order to save for your future? My advice is to begin with the end in mind and start where you are. A few questions to ask yourself:
What lifestyle are you creating?
What kind of lifestyle do you want to have in retirement?
Are you just now starting to plan for retirement, or are you vested in other plans and have other assets?
What type of freedom would you like in terms of how your retirement funds are invested within your accounts?
Freelancers and independent contractors can navigate these and other retirement considerations with a proactive approach and advice from a financial professional. While certain plans can be a bit more complicated – many options require calculations based on owner compensation, business profit, etc., –there are outsourced human resources, accounting and advisory services that can help you determine what is best for you and your specific needs.
Key considerations for freelancers
It’s important to maximize your tax deferrals and minimize business tax liabilities to leverage retirement options available to freelancers and independent contractors, and to understand the risks and limits involved in the options available.
If you also work as an employee and are eligible in other plans, you may also want to access any employer contributions and tax deferral benefits that are available to you as an employee. If you own a small company and do not have an appetite for extra administrative work, or the budget to retain additional financial advice, selecting plans that are simple to set up and maintain and that have little-to-no Employee Retirement Income Security Act (ERISA) reporting requirements may be a good option for you.
Reviewing Your Options
Some of the retirement options available to business owners are a Self-Employment Pension Individual Retirement Account (SEP IRA) Plan, Solo Individual Retirement Account(IRA), and Cash Balance Pension plans. Let’s briefly dive into each plan.
A SEP IRA is simple to set up and supported by many financial institutions. This type of plan allows the business owner to contribute up to 25% of net self-employment income salary on an annual basis, with the annual contribution being $56,000 for the 2019 tax year; the limit is adjusted due to inflation annually. If you have employees in your business, you will be required to have a non-discriminatory plan where your employer contribution must be the same percentage for the business owner and employees.
A Solo IRA is a plan designed for business owners who do not have any other employees aside from the business owner and their spouse. This plan can be brokerage-based and self-directed. For example, you can invest in real estate in a self-directed plan. Elective deferrals of earned income is limited to $19,000 for 2019; the limit is adjusted due to inflation annually.
Cash Balance Pension Plan
Cash Balance Pension Plans are qualified plans where each participant has a separate account. The employer makes two contributions: one based on credit per employee and the other based on the account performance. The credit contribution is typically based on a percentage of compensation. The interest credit varies depending on market volatility and gains. This may be a good option for businesses who have consistent profits and whose owners who want to maximize retirement contributions and tax deductions. The contribution limit is $225,000 for 2019; the limit is adjusted due to inflation annually.
The Bottom Line
When planning for retirement, freelancers and independent contractors should use a holistic approach and consider their overall current and future financial and personal goals. Cash flow, short term liquidity and business growth needs should be taken into consideration, along with retirement lifestyle and needs funding. Understanding what your needs, wants, and obligations will be during your retirement years can help you determine how much you are willing to balance and contribute currently. Assessing account performance periodically and whether additional planning is needed is important as well. Working with a financial professional who offers proactive, holistic advisory services and helps you work with a team of professionals may be a great investment and help you in your journey to plan for a bubbly retirement.
Cheers! Here’s to a happy and fruitful retirement.
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This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
Iralma Pozo, CPA is an independent consultant with more than 15 years of financial expertise. She is an active member of the New York State Society of Certified Public Accountants. (NYSSCPA,) currently serving on the Statewide board and various committees. She is an adjunct lecturer at various colleges where she teaches undergraduate and graduate students accounting courses. Connect with her on LinkedIn.